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Designing Financial FreedomSun, 11 Mar 2018 17:53:25 +0000en-UShourly1https://wordpress.org/?v=4.9.4Should I Put Money in a 401(k) or IRA First?http://feedproxy.google.com/~r/MyMoneyDesign/~3/K_QXTjA5wUE/
http://www.mymoneydesign.com/personal-finance-2/retirement/should-i-put-money-in-a-401k-or-ira-first/#respondSun, 11 Mar 2018 06:00:13 +0000http://www.mymoneydesign.com/?p=10337So you want to save for retirement. You’ve heard good things about both 401(k)’s and IRA’s. But you’re limited on funds. You’d like to save your money in both, but that’s not just happening. (At least not today.) So if you only have to pick one, which is it going to be? In this post, […]

But you’re limited on funds. You’d like to save your money in both, but that’s not just happening. (At least not today.) So if you only have to pick one, which is it going to be?

In this post, we’ll skip all the boring, recycled facts about retirement planning and get straight to the point of addressing this question: Should I put money in a 401(k) or IRA first?

Why Either is a Good Choice

First of all, understand that for most people: You can do both. It’s very common for most middle-class Americans to be able to save their money in both an IRA and 401(k). To be sure if you qualify, check the IRS requirements here.

In addition, both options are a great choice over traditional bank accounts because they offer the unique advantage of tax-deferment.

Remember that when you save your money in a regular bank account, it’s with AFTER-tax income from your paycheck, meaning that you’ve already paid taxes on this money. On the other hand, with retirement accounts, you make your contribution BEFORE the taxes are taken out.

Why does that matter? Let’s say you have the choice to save $10,000 of earnings this year. By the time you receive that money in your paycheck, it will be approximately $7,500 because $2,500 went to taxes. But with your retirement accounts, you get to stash the whole $10,000. That’s a huge 33% difference!

Okay, so back to the original question: Where do we start saving first?

1- 401(k) Employer Matching Contributions

The first question to ask yourself is whether or not your employer offers you any sort of 401(k) matching contribution. This is money that your employer kicks-in to your 401(k) alongside your contributions.

If your employer does this, start saving your money inside your 401(k) and do everything you can to maximize it!

Seriously. Passing up employer contributions is like leaving free money on the table. It’s just plain foolish. I’m sure if your boss was walking around passing out $100 bills, you wouldn’t pass that up. So why pass up the chance to collect the same thing using your 401(k)?

According to Investopedia, on average, most employers will match anywhere between 50 cents and $1 for every $1 you contribute to your 401(k) (up to some pre-set maximum amount).

Wow! A dollar for dollar match? You’d be effectively doubling your money for doing nothing more than simply choosing to save it.

Also not to mention that, just like your contributions, this money grows tax-deferred until someday in the future when you withdraw it for retirement. Good deal!

Unfortunately for the IRA, since this is your personal plan, it is extremely rare for employers to help in any way with contributing to it.

2- Fees and Flexibility

Following employer matching contributions, the next point to consider on using a 401(k) or IRA first is that of fees and flexibility. And in this debate, usually the IRA wins.

Because you can choose which investment company to start your IRA, you’re going to find a lot less expensive options than probably what your 401(k) will offer.

For example: My go-to for investing is Vanguard. They offer lots of fund choices that carry an annual expense ratio of 0.25%. In fact, they’ve got a very popular stock market index fund that costs only 0.04% per year. This means you’re paying $4 for every $10,000 you’ve got invested. That’s almost nothing!

Combine this with the fact that IRA’s don’t have any administrative fees. 401(k) plans do. Most people don’t realize it, but they’re actually also paying an additional fee to their plan administrator to simply “run” the 401(k). CNBC found that depending on the size of your company’s plan, this could be an extra 0.27 – 1.13% annual expense.

Also because you get to choose who your IRA is through, this gives you an added benefit of choosing among thousands of options. With a 401(k), most of the time your plan is limited to only the choices that your plan administrator will allow. If you don’t like those options, then you’re generally out of luck.

Finally, with IRA’s, you have a little bit more flexibility over the fund. With 401(k)’s, you have to ask for your plan administrator’s permission to take out loans or file for special withdrawals. With an IRA, since you are the boss, you make these decisions with your investment service provider.

Bottom line: After contributing as much as you need to get your full 401(k) employer match, save the remainder to your IRA.

3- How Much Do You Plan to Contribute?

After fees, the next topic to consider is how much you plan to save up every year.

This is where IRA’s fall short. As of 2018, the maximum annual contribution you can make to an IRA is $5,500 (or $11,000 for couples). That’s not nearly as much as the $18,500 you’re allowed to stash away in your 401(k).

Therefore, 401(k)’s will provide you with more room to stash your savings tax-deferred.

Bottom line: After you’ve maxed out your IRA, you should then switch back over to your 401(k) and continue to save your money there.

Do I Use a Roth or Not?

One more ingredient to make this subject just a little bit more complicated is the issue of whether or not to use a Roth-style account.

As you might already know, Roth accounts are the opposite of Traditional-style accounts. With a Roth, you pay your taxes now, the money grows tax-free, and then remains tax-free even after you’ve retired.

To Roth or not comes down to one simple question: Do you think you’ll have more expenses now or in the future?

What is this question getting at? It’s trying to identify whether you think you’ll be in a higher tax bracket now or later.

If you think you’ll have fewer expenses at retirement, then this means you’ll likely need less money, be in a lower tax bracket, and therefore the Traditional style account would be better suited for you.

But if you plan to live more luxuriously, travel, or just plain enjoy your money more in retirement, then chances are you’ll be in a higher tax bracket and the Roth makes more sense.

To find out more about the differences between Roth and Traditional style accounts, check out our full guide here.

Maximize Your Savings

Again: The best-case scenario when it comes to using your retirement plans is to max them all out as much as possible.

When you do this, it accomplishes every one of the goals we’ve discussed so far:

Minimizing your taxes as much as possible, which translates to more money in your pocket.

Maximum employer contributions.

Tax-deferred or tax-free growth.

If you’re looking for some practical tips on how you can start saving more your hard-earned income, then please check out my book Save MORE, Earn MORE. Here you’ll find some proven strategies for stashing more of your money every year.

Readers – Where do you recommend to your friends that they put their money first – a 401(k) or IRA? What order or strategy do you like to use to get the most out of each one?

Related posts:

]]>http://www.mymoneydesign.com/personal-finance-2/retirement/should-i-put-money-in-a-401k-or-ira-first/feed/0http://www.mymoneydesign.com/personal-finance-2/retirement/should-i-put-money-in-a-401k-or-ira-first/Is a Gym Membership Really a Big Waste of Money? Not According to These Calculationshttp://feedproxy.google.com/~r/MyMoneyDesign/~3/rLmNIsKMIH4/
http://www.mymoneydesign.com/lifestyle/philosophy-motivation/is-a-gym-membership-a-waste-of-money/#commentsSun, 25 Feb 2018 12:13:53 +0000http://www.mymoneydesign.com/?p=10331Here’s a piece of advice you’re not going to hear often on a money blog: If you’ve got a gym membership and you love going there, it’s okay. You don’t have to quit just to save money. Really.. it’s fine. Contrary to some of the other personal finance advice you might read out there, you’re […]

]]>Here’s a piece of advice you’re not going to hear often on a money blog: If you’ve got a gym membership and you love going there, it’s okay. You don’t have to quit just to save money.

Really.. it’s fine.

Contrary to some of the other personal finance advice you might read out there, you’re not committing some kind of financial suicide. The frugal police aren’t going to come bust you.

In countless articles I’ve read, one of the first areas they always suggest you cut out of your life is that “high-priced” gym membership.

And I get it. According to USA Today, the average price of a typical gym membership these days costs just under $60 per month.

And to make matters worse, 67% of them go unused. For those people , that’s just plain silly. I’ll send you my PayPal address if you want to give away $60 every month.

But what about all the people who actually DO use their memberships? Are they being ridiculous for paying to go to the gym? Couldn’t they just work out at home and accomplish the same thing?

I don’t necessarily think so … I’ve been there, and I’ll tell you why.

The Failure of Our Home Gym

When my wife and I met in college, we were both really good about going to the gym. Then after we got married and we bought our first house, I made a small investment into some free weights and a treadmill. “I’ve done it!” I triumphantly thought … Now we won’t need to pay a whole bunch of money every month for gym memberships!

For a while it worked. Sorta … My wife and I would go through streaks where we’d work out. But it would only be for 20-30 minutes tops. And between work and all the other stress in life, it was WAY too easy to just let our downstairs gym collect dust most days.

Then last Fall, my wife and I decided to give the local Planet Fitness a try. What a difference that’s made! Now we both go regularly 3 or more times per month as a way of staying accountable for putting the membership to good use.

It started out as $20 per month and has now increased to $40 per month since we started bringing our two teenage kids.

Though I realize that’s roughly an expense of $480 per year, I’m not at all fazed by this. Not one bit.

First, there’s the fact that our overall health has improved significantly! Since joining I’ve already dropped 25 lbs and am starting to regain some of the stronger physique I had all the way back in college.

On top of that, going to the gym has become a wonderful bonding activity that my wife and I can do together several times per week; each motivating the other to become more fit.

So how does that break down into dollar and cents?

Having Fun Together for $1.33?

I could argue that financially going to the gym is one of the cheapest activities around that you could spend your money on.

For example, take the average family of 4 going to dinner. This can be a very fun night out together. But with our two teenage children, it costs us generally $50-$80 by the time we get our bill. That’s quite an expensive activity!

Going to the gym, on the other hand, costs our whole family $40 for the month. Repeat: For the month!

This means if you calculate out the dollar amount spent per visit, we could literally go there every day as a family for approximately $40 / 30 = $1.33 per day. I can’t even take myself and my wife out to get coffee for $1.33. The only activity that even comes close is when we used to take our kids (when they were small) to the local park to play (free).

Now, of course, unless you’re some kind of gym rat, no one is going there 7 days per week. So let’s use more realistic numbers. As I mentioned, on average we’ve been going 3 days per week. We’ll call this 12 times per month. Now we’re up to a whopping $40 / 12 = $3.33 per visit. This is still almost nothing when you put it in the perspective of the cost of all the other activities you could be doing.

Therefore, financially I conclude that among the majority of the other activities you could pick to occupy your time, going to the gym will likely be one of the cheapest when you actually calculate out the amount of money spent per visit. The condition, of course, is that you actually USE your membership regularly.

But that’s not even the biggest reason why I argue that it’s okay to go to the gym …

You Should Spend Your Money How YOU Want To

The biggest point I’m trying to make here is this: YOU are in charge of what you spend your money on.

In the wide-world of personal finance, you often hear a lot of opinions about what you should and should not spend money on. Sometimes you hear so many different ones that your brain begins to wonder if there’s anything acceptable to purchase.

The answer is: Of course there is! But its up to you to figure out what that something is. And it doesn’t matter if it’s a gym membership or trying out the latest craft beers, going to rock concerts, ukulele lessons, traveling to exotic locations, … whatever! The choice is yours.

Again, this is all assuming your financial household is in order. As long as you’re hitting your money goals and thinking long-term, you should be able to enjoy the excess. Enjoying the fruits of your labor here and there is what keeps you fresh and motivated to work even smarter.

Don’t be derailed by the noise of others. Let them spend their money they want, and remember that you are allowed to do exactly the same.

]]>http://www.mymoneydesign.com/lifestyle/philosophy-motivation/is-a-gym-membership-a-waste-of-money/feed/1http://www.mymoneydesign.com/lifestyle/philosophy-motivation/is-a-gym-membership-a-waste-of-money/How Much Should I Contribute to My 401(k) Plan? This is the Number You Need to Hit!http://feedproxy.google.com/~r/MyMoneyDesign/~3/EmtorpmQKdE/
http://www.mymoneydesign.com/personal-finance-2/retirement/how-much-should-i-contribute-to-my-401k-plan/#commentsSun, 11 Feb 2018 06:00:10 +0000http://www.mymoneydesign.com/?p=7984If there’s one question about retirement planning that many people feel unsure about, it’s this: How much should I contribute to my 401(k) each year? Seriously … what’s the magic answer? Is it 5%? 10%? 15%? Take a stroll around the Internet, and you’re bound to find a number of opinions from reputable sites. For […]

]]>If there’s one question about retirement planning that many people feel unsure about, it’s this: How much should I contribute to my 401(k) each year?

Seriously … what’s the magic answer? Is it 5%? 10%? 15%?

Take a stroll around the Internet, and you’re bound to find a number of opinions from reputable sites. For example, Investopedia is quoted as saying that “a good sweet spot is between 10% to 15%”.

That’s not surprising; especially when you consider that when you’re young (in your 20’s and 30’s) and just starting out, retirement can feel like such a long ways away.

You know you should be saving up for the future. But at the same time you’ve got to balance your finances against goals that are in the present such as your family, vehicles, house, etc. And so 10% to 15% seems like a good compromise. (… The only problem is that we tend to contribute much less than that; 6.2% according to Vanguard.)

While all of this may be fine and good, I believe that if more people were to look at contributing to their 401(k) accounts the way that I’m about to show you, then they would be saving a WHOLE LOT MORE!

As you’ll see, it’s a grand opportunity to take advantage of some major, major savings.

This is why when people ask how much they should be contributing to their 401(k)’s, my answer is simple: Contribute the max!

Why You Should Contribute the Max to Your 401(k)

Let me ask you a question: Do you like to buy stuff when it’s:

Full price or

On sale?

I think most of us would agree that “On Sale” is the way to go! And if you’re anything like me, then you LOVE getting a good deal on something you were planning to buy anyways.

Well, believe it or not, this simple analogy applies to your retirement savings too. You have the option to either:

Save a portion of your paycheck in a regular bank account.

Save a MUCH LARGER portion of your paycheck without any extra effort using your 401(k)!

How is that possible?

Simple … by legally avoiding paying TAXES!

Let’s break this down using a single dollar as an example …

Saving 28% More of Your Money

For every dollar you earn, you know that you must pay taxes on it.

Using the new Federal average tax rate of 22%, this means that:

For every $1.00 earned,

Roughly $0.22 goes to taxes and

Roughly $0.78 is leftover for you to save, spend, … do with as you please.

This means that if you simply put your money in a bank account after taxes are paid, for every $1 you had hoped to save, you’re really only saving $0.78 of it.

That’s NOT a very good deal.

Now let’s look at how this works when we use a 401(k) instead:

For every $1.00 earned,

$0 goes to taxes. Remember that with a 401(k), you get to defer your taxes for decades later into the future until you are finally withdraw the money.

Therefore, the whole $1.00 gets saved!

This is the fundamental benefit of using a 401(k) to save for retirement. You get to keep both the $0.78 you would have saved PLUS the $0.22 you would have paid towards taxes!

Which would you rather have available to save: $0.78 or $1.00?

Clearly being able to save the $1.00 using a 401(k) is the better choice! That’s roughly ($1 – $0.78) / $0.78 = 28% more for doing nothing more than being smart about how you save your money!

So, now that you understand how tax-advantaged savings with a 401(k) works, how can you use this information to get the MAXIMUM amount of benefit?

As I said before: MAX out your savings; all the way up to the IRS contribution limit!

How Saving the IRS Max = +$4,000 Saved!

Let’s reach for the stars for a minute and consider what the benefit would be of reaching this upper limit …

Using the same numbers as our previous example, we now have:

$18,500 is earned,

$18,500 x 22% = $4,070 goes to taxes and

$14,430 is leftover for you to save.

But again, by saving our money using our 401(k):

$18,500 is earned,

$0 goes to taxes. (Taxes are deferred.)

Therefore, the whole $18,500 gets saved!

Again, by using your 401(k), you get to keep both the $14,430 you would have saved PLUS the $4,070 you would have paid towards taxes!

How many other strategies do you know of where the benefit is getting to save an extra +$4,000? To me, this is an incredible incentive to reach that IRS upper limit each and every year.

Bonus tip: Keep in mind that this strategy works per person. If you’re a couple and you both contribute to your own 401(k) plans, you have the opportunity to actually DOUBLE this benefit by saving over $8,000 per year!

Tax-Deferred Growth for Years to Come

If that’s not already awesome enough, now consider this: All that extra savings will now grow and compound each year tax-deferred!

Remember that your 401(k) isn’t just a savings account. It’s an investment account. This means that every dollar extra you contribute has the capacity to grow and multiply for years and years to come.

This additional savings of +$4,000 is no small addition. If we look at just the difference this amount makes by NOT going to taxes, we can calculate that $4,070, over the next 30 years at a rate of 7% annually has the potential to increase to as much as $384,455.

That’s a pretty substantial increase to your nest egg!

Saving More is the Quickest Path to Financial Freedom

I usually recommend maxing out your 401(k) if for no other reason than to simply keep more money for yourself instead of paying it away in taxes.

But there is also another very IMPORANT benefit …

A high level of personal savings is the quickest and surest way to achieve financial freedom!

Believe me. I’ve read hundreds of F.I.R.E (financial independence, retire early) stories. And almost every time, behind each one, you can find that the individual or couple used a high level of savings in order to achieve their goal. In fact, here are six F.I.R.E. stories that you can check out for yourself.

I’m not talking in their 50’s and 60’s. These are people in their 40’s or even 30’s who became so financially stable that they were able to walk away from full-time employment and go do whatever makes them happy.

How is this possible?

It’s due to something I call the double-ended approach to early retirement. By saving more, you essentially teach yourself to live off of less money. This then leads to you needing less money to achieve financial freedom. And thus you reach your goal faster. You can read all about it in this post here.

So now you’ve got two VERY good reasons to strive to max out your 401(k): Keeping more of your tax money for yourself, and reaching financial freedom quicker!

Great! Now How Do I Get My Savings Rate So High?

Being able to contribute all the way up to the IRS 401(k) max of $18,500 is not something that most people will be able to do overnight.

Just like someone on a diet who wants to lose weight, it’s going to take a lot of discipline and will-power to get there. But given time, if you stay consistent, you will reach your goal!

It look us years to get to the point where my wife and I could each hit the IRS max limits. We started off much like everyone else contributing 10% or so to our plans. But little by little, we kept increasing our contributions until we had finally hit the ceiling.

How did we do it?

My favorite strategy is the raise trick. This is where you raise your limit every time you get a new raise at work. By doing this, you never end up missing the money because you never know any different from the previous year.

At a Minimum, Get the Full Employer 401(k) Match

Okay, okay. I perfectly understand that saving $18,500 will not fit into everyone’s financial situation.

My goal here was to illustrate just how great this strategy can be if you scaled it for maximum benefit.

At the absolute minimum, there is one threshold you should under no circumstances go below: Contributing as much as needed to get the full 401(k) employer match.

For me, this is the one number that is non-negotiable.

Why? Because anything less than this and you are simply passing up FREE money.

Most U.S. employers will now pay an incentive to their employees in the form of a 401(k) match. Sometimes this might be 50 cents to a dollar. Or sometimes its as much as dollar for dollar. On average, this works out to a match of roughly 2.7% of the employees pay.

Keep in mind that just like your 401(k) contributions, this money is tax-deferred too – meaning you pay no taxes on it right now. PLUS: It grows tax-deferred too!

So if you contribute anything less than this amount to your 401(k), you’re simply leaving money on the table. A LOT of money over time!

Don’t believe me? Just check out how much more that can build up your 401k over time at this post here.

To know for sure what this minimum amount should be, go to your 401(k) provider or HR representative and get the details. Every employer’s rules will be different.

What If I Don’t Like My 401(k) Plan or Can’t Contribute to One?

Unfortunately, not all 401(k) plans are the same.

Some offer really good terms while others …. not so much. It all depends on how your employer has setup the plan.

Consider:

Some have lousy or expensive investment options

Some plans charge high administrative fees.

Some don’t allow you to borrow or make it nearly impossible to make a withdrawal, even with a financial hardship.

Some won’t let you file for a 72t or SEPP if you plan to retire early.

If you have encountered these problems or your employer simply doesn’t offer 401(k) plans, relax.

The IRS also gives the option to contribute to a Traditional or Roth IRA. Like a 401(k), these savings plans allow you to make tax-advantaged contributions that can grow and compound your nest egg. But the major difference is that an IRA is under your control; it is completely separate from your employer.

Also, if you’d like more details on how IRA’s differ from 401(k) plans, then please read this post too.

But How Do I Know Exactly How Much I Should Be Saving?

I get it. Maybe you want to save just as much as what you need to successfully retire one day.

But how does someone find out what they number is?

With all the noise that’s out there in financial media, it’s a wonder anyone knows what’s real and what’s just there as link-bait.

I’ve read everything from articles suggesting you save up multi-million dollar nest eggs to moving to third-world countries for retirement. No thanks!

Over time, as I tested my own plans, it became clear to me that a lot of what I was doing could be used by others to help them realize their paths to financial freedom too.

This is what inspired me to write my book “How Much Money Do I Really Need to Retire & Achieve Financial Independence?”.

In it, we take a very straight-forward and practical approach to answering the question: How much do I really need to save? What you’ll discover is that depending on how you want to live in your retirement, you might not need millions of dollars at all. In fact, you might be just as safe and secure with less; not to mention a whole lot happier you were able to stop working much sooner.

]]>http://www.mymoneydesign.com/personal-finance-2/retirement/how-much-should-i-contribute-to-my-401k-plan/feed/25http://www.mymoneydesign.com/personal-finance-2/retirement/how-much-should-i-contribute-to-my-401k-plan/Yes, You Can Use Your Roth IRA as an Emergency Fund – Here’s the Proper Way Howhttp://feedproxy.google.com/~r/MyMoneyDesign/~3/i-lJodROcwo/
http://www.mymoneydesign.com/personal-finance-2/savings-budgeting/roth-ira-as-an-emergency-fund/#respondSun, 28 Jan 2018 06:00:20 +0000http://www.mymoneydesign.com/?p=10305If you’re struggling to save for both retirement as well as be prepared for whatever life throws your way, then here’s something useful for you to know: You may be able to use your Roth IRA as an emergency fund. Yes, because of the unique withdrawal rules for Roth IRA’s, they have the potential to […]

]]>If you’re struggling to save for both retirement as well as be prepared for whatever life throws your way, then here’s something useful for you to know: You may be able to use your Roth IRA as an emergency fund.

Yes, because of the unique withdrawal rules for Roth IRA’s, they have the potential to serve double-duty and accomplish both goals. You can be well-prepared for the unexpected as well as work on building up your future nest egg.

Since these two types of accounts are generally best kept separate, there would be some potential pitfalls to watch out for if you choose to use this strategy.

Let’s take a look at the pros and cons of both sides.

Advantages of Using a Roth IRA as an Emergency Fund

Assuming you’re not able to fund your Roth IRA and emergency fund separately, this strategy of combining their forces can give you some unique advantages.

Accessibility

According to the IRS rules, because Roth IRA’s are funded with after-tax money, this makes the contributions portion accessible whenever you want. You only technically have to wait to touch the earnings part of your IRA (i.e. the money that grew on top of the money you contributed).

This is unlike a traditional IRA or 401(k) where you have to wait until age 59-1/2 to access any part of your savings; contribution or earnings.

Earns Market Rate

One of the big complaints that most people have when it comes to emergency funds is that the money sits around doing nothing. At last check, online banks were paying somewhere around 1%. If you compare that to the average rate of inflation at 3%, then it’s almost as if you’re actually losing -2% of your purchasing power every year.

That’s where a Roth IRA can be helpful. Typically with any sort of retirement fund, you can invest in funds that are going to deliver a much better long-term rate of return than a bank account. Even a conservative bond fund earning 4% average returns would be a better use of your money.

Tax-Deferred Growth

To build upon the last point, the other thing that using your Roth IRA for emergency funds does is to allow your savings to grow tax-free.

As you may already know, the design of a Roth IRA is that you do not pay taxes on your money in the future since you’ve already been taxed on the contributions in the present. This is the opposite of a traditional IRA or 401(k).

With bank interest or other types of investments, you typically owe some sort of taxes to the IRS. So by using a Roth IRA, you avoid this completely.

Disadvantages

Using your Roth IRA as your emergency fund is not a fool-proof strategy. There are some potential disadvantages if you’re not careful.

Tapping for the Wrong Reasons

Just because you have access to your money doesn’t mean you should use it. Retirement funds are intended to be set aside for long-term growth and money in the future.

This is why if you do need to access your IRA funds, you should only do so in the case of “real” emergencies. Don’t tap your Roth IRA to cover small expenses like unexpected bills or repairs. For these types of expenses, I’d recommend you keep a small buffer of cash in your savings. Even $1,000 or so would leave you less tempted to tap your funds.

Hurting Potential Future Growth

The major reason you don’t want to touch your Roth IRA funds if you don’t have to is because it will destroy your future earning potential.

Those contributions need to be present in order to collect earnings. If you remove them, then there’s nothing to generate earnings.

Think of it this way: If you’ve got $10,000 set aside in your Roth IRA and it generates 10% earnings, then you’d make $1,000. Plus it could earn that much or more every year thereafter. But if you remove $5,000 for your emergency needs, then you only leave $5,000 in the fund. That means you’re only going to earn $500. Plus you’ll be crippling yourself for years to come.

Invest Conservatively

While I normally recommend investing aggressively for long-term goals like retirement, if you want to use your Roth IRA as an emergency fund, then you may want to invest more conservatively than you normally would.

This is because when it comes to your emergency savings, you want your money to be around when you need it. But if you invest aggressively, you have no control over what the markets will do to the value of your savings. They might go down or up. And as luck will have it, you’ll probably end up needing them during a down-point.

Tempted to Use the Earnings Too

Remember how we said that the earnings portion of your Roth IRA is off limits? Unfortunately it could be tempting to withdraw this part of your savings alongside your contributions if you’re in a true emergency situation. But remember that if you do, you’d be subject to pay the IRS taxes plus a 10% penalty.

Conclusions

Again, I’m only recommending this combination strategy if you don’t have enough money to do both. The best case scenario would be that you find a way to keep your retirement savings and emergency fund separate. But if that’s not a possibility for you, then this strategy might help you get the best of both worlds.

Remember that as of 2018 each person can contribute as much as $5,500 into your Roth IRA. That’s $5,500 or $11,000 for a couple as long as you meet the IRS income requirements. (Actually, you can still contribute to one even if you earn too much – here’s how.)

If you do end up making any withdraws, be sure to report it on your taxes or to your tax preparer. You will need to fill out IRS Form 8606.

Readers – What do you think about using your Roth IRA as an emergency fund? What potential advantages or disadvantages do you see in using this strategy?

]]>http://www.mymoneydesign.com/personal-finance-2/savings-budgeting/roth-ira-as-an-emergency-fund/feed/0http://www.mymoneydesign.com/personal-finance-2/savings-budgeting/roth-ira-as-an-emergency-fund/401(k) vs IRA – Which Is Better For My Retirement Savings?http://feedproxy.google.com/~r/MyMoneyDesign/~3/FkOynLCX7T0/
http://www.mymoneydesign.com/personal-finance-2/retirement/401k-vs-ira-which-is-better-for-my-retirement-savings/#commentsSun, 14 Jan 2018 06:00:42 +0000http://www.mymoneydesign.com/?p=10277When it comes to saving for retirement, there are two main tools for you pick from: A 401(k) vs IRA. Though most people will be able to contribute to both, there can be some unique advantages to using one or the other. For example: 401(k) plans have higher contribution limits making them more attractive for […]

]]>When it comes to saving for retirement, there are two main tools for you pick from: A 401(k) vs IRA.

Though most people will be able to contribute to both, there can be some unique advantages to using one or the other.

For example: 401(k) plans have higher contribution limits making them more attractive for savers who set aside a higher percentage of their income. But you have to work at a place that offers you a 401(k) in order to participate. If you don’t, an IRA could be better tool for you to use at your disposal.

If you’re an early retirement seeker like myself, both types of plans can also offer some useful tricks that will enable you to get access to your money before the IRS minimum age requirement.

Here are the highlights of a 401(k) vs IRA and why one type may be better suited to your needs.

How They Work / Taxes

Advantage: Both!

One clear benefit to using either a 401(k) or IRA is that they both give you the chance to save money before taxes are taken out. At a tax rate of 25%, that works out to roughly 33% more money saved than if you had tried to save your money post-tax in a regular bank savings account.

The mechanics of both are a little different, but they accomplish the same end goal. With a 401(k), your contributions are taken out of your paycheck pre-tax giving the tax-deduction immediately. With an IRA, you make contributions and then declare them when you file your Federal tax return. Both paths ultimately result in lowering your taxable income at the end of the year.

Contribution Eligibility

Advantage: IRA.

While the 401(k) has become one of the most popular types of retirement plans available, it is still fundamentally a “work-place” plan. This means your employer has to offer one in order for you to participate. Unfortunately, according to Bloomberg this means that 1 out of 5 workers ends up getting left out in the cold.

By contrast, an IRA is an “individual retirement arrangement”. This means it is a retirement plan that you start and manage yourself. All it takes to get started is going online or making a phone call with any brokerage of your choice.

The main requirement of being able to contribute to an IRA is that you need to have earned some taxable income this year. But there is one small catch: Your contribution may or may not be tax-deductible depending on your income level, filing status, and contributions to other retirement plans. The best way to know for sure is to have a look over the official IRS eligibility requirements.

Remember that since you’re saving roughly 25 cents in taxes for every dollar you contribute, that higher limit could mean big savings for you! Consider that hitting the maximum contribution would mean:

401(k) = $4,625 in taxes saved

IRA = $1,375 in taxes saved

If you’re age 50 and over, the same goes for Catch-Up Contributions. 401(k)’s will let you add an extra $6,000 whereas IRA’s only let you contribute another $1,000 on top.

Employer Matching Contributions

Advantage: 401(k).

Employer matching contributions are another huge advantage of using your 401(k). Most employers who offer them will also offer some sort of match; the most common being 50 cents for every dollar you contribute.

Unfortunately with IRA’s, this would be rare – if ever done at all. Because the IRA is something you manage, employers don’t typically get involved.

Honorable mention for the IRA: If you earn money on the side or are self-employed, than participating in something called a SEP IRA can be a huge benefit to your taxes. I do this every year, and it not only lowers my tax burden, but allows me to stash away another $3,000-$4,000 away for retirement. That’s on top of any other 401(k) or IRA contributions I’ve already made!

Investments

Advantage: IRA.

IRA’s are great because YOU get to choose who and what you’d like to invest in. That means you could go to a broker that offers mutual funds, ETF’s, stocks, bonds, etc. But it could also mean that you include other alternative assets like real estate or precious metals.

Unfortunately with a 401(k), you’re stuck with whatever funds your employer is offering. Case by case, this could be either really good or bad. I’m very fortunate to work for a company that uses Fidelity for their 401(k) plan, and they offer more funds than I could ever care to choose from. But I’ve also heard horror stories of employers who go through some less creditable brokers and offer some very poor fund choices.

To know if you’re 401(k) fund choices are on par with the rest, look at 1) the performance of the funds and 2) the expenses. There should be at least a few funds that compare in performance to that of a simple stock market index fund (returning roughly 10% per year). The expense ratios should also be less than 1%. Less than 0.5% would be even better.

Roth-Style Accounts

Advantage: Both (IRA slightly ahead)

If you prefer the setup of a Roth-style retirement savings plan, than you’re usually in luck! Most of the time, both types of accounts are offered.

With a 401(k), this will depend on your employer’s plan. If they haven’t updated your plan to include this option, then unfortunately you are out of luck.

That’s why I give a slight advantage to the IRA. You always have the option of choosing either a traditional style or Roth style right from the opening.

Fees

Advantage: IRA (usually).

Again, because your employer dictates which funds you can pick from in the 401(k) plan, you’re somewhat stuck paying whatever the broker charges.

But on top of that, 401(k) funds also usually charge some sort of administrative fee. This is a sort of “overall” fee simply for managing the plan. Depending on how much of this expense your employer absorbs, this fee could impact your net savings rate as well.

By contrast with IRA’s, because you can choose where you start them, this means you have the freedom to select a low cost provider like Vanguard or Fidelity. Funds there can cost as low as $5 for every $10,000 invested. Plus, there are usually not any administrative fees since the tracking is all part of their normal paperwork tracking.

Loans:

Advantage: 401(k). If your employer allows you, you can take a sizeable loan from your 401(k) to help cover emergencies. You’ll have 5 years to pay it back. With IRA’s, the term is much shorter limited to just 60 days.

Early Retirement (Less Than 5 Years):

Advantage: 401(k). If you plan to retire by age 55 or older, 401(k)’s offer you a special exception known as the Age 55 Rule where you can start taking your money out early penalty-free. IRA’s do not offer this.

Early Retirement (5 or More Years):

Advantage: IRA. If you plan to retire much sooner than your peers, than you will need to be very strategic about how you withdraw your money. This will usually involve taking out a 72t or making Backdoor Roth IRA Contributions. Both of these strategies will be much easier to execute if you do them inside your IRA instead of your 401(k).

Conversions / Rollovers

Advantage: Generally the same; IRA’s are easier.

For most financial companies, conversions and rollovers are no problem. Usually going from a 401(k) to an IRA or a traditional to a Roth style account involves nothing more than a phone call or completing an online form.

However, as we’ve mentioned with 401(k)’s, your employer’s plan has to allow these sorts of things in order for them to occur. This will vary case to case.

With IRA’s, the decision is all yours. That makes it much easier to do.

Required Minimum Distributions

Advantage: Same.

The IRS requires you to start making mandatory withdrawals on your tax-deferred accounts starting at age 70-1/2. This will apply to both your traditional 401(k) and IRA.

If you elected either to be Roth-style, then RMD’s are not required (since you’ve technically already paid taxes on this savings).

Beneficiaries

Advantage: Same.

The IRS allows you to pass on the money from either a 401(k) or IRA to your spouse as if it was their own. If you leave either to someone else, they will be required to start making mandatory withdrawals and pay taxes on it.

Readers – Which do you prefer between a 401(k) vs IRA? What are some of the positives and negatives that you’ve found to using one versus the other?

Related posts:

]]>http://www.mymoneydesign.com/personal-finance-2/retirement/401k-vs-ira-which-is-better-for-my-retirement-savings/feed/1http://www.mymoneydesign.com/personal-finance-2/retirement/401k-vs-ira-which-is-better-for-my-retirement-savings/Monthly Budget Not Working? Why An Annual Budget Is Betterhttp://feedproxy.google.com/~r/MyMoneyDesign/~3/6moiOU3gn6I/
http://www.mymoneydesign.com/personal-finance-2/savings-budgeting/annual-budget-vs-monthly-budget/#commentsSun, 07 Jan 2018 06:00:03 +0000http://www.mymoneydesign.com/?p=10301We all know that budgeting is the key to managing our money. But have you ever considered how an annual budget might work better than a monthly budget? Tell me if this is how budgeting usually goes for you … You take your annual income, divide it by 12, and then make a goal to […]

]]>We all know that budgeting is the key to managing our money. But have you ever considered how an annual budget might work better than a monthly budget?

Tell me if this is how budgeting usually goes for you …

You take your annual income, divide it by 12, and then make a goal to not spend over that amount each month. Things might go well for a little while. But then you find that you’ve over-spent by $500 because of a bill you weren’t expecting. Then the next month its $1,000 more than you anticipated.

Perhaps you’d like to buy a new car, but you’re unsure of how much you can actually afford each month. Or maybe you’d like to boost your 401(k) savings rate. But again – how much extra can you actually put aside without breaking the bank?

This was exactly how budgeting used to go for me every month. Then one day, while at work, we started going over the annual budget for the next year. There it was, right in front of me … a spreadsheet with exactly what the company planned to spend and earn for the entire year. It was a complete financial picture of what was going to happen! No surprises or slip ups. Pick any month, and you could see just how many planned expenses they had and how much cash they had to cover it.

That’s when it hit me … As the family CFO, I need to do the same thing! I need to setup our family budget like a business that plans to succeed! And that means we need to get a complete picture of how our finances will look over the course of the whole year, not just month to month.

Shortly after that, I did just that. I made a list of all our expenses, carried them forward throughout an entire year, and then compared it to our income to determine just how much money we “really” had available to spend.

It’s a strategy that’s been working great ever since! If you have any doubts, here are a few reasons why you’ll want to consider an annual budget vs monthly budget.

Missed Expenses

With a monthly budget, there are several expenses that get missed because you simply don’t think about them every month.

Consider the following heavy-hitters:

Christmas gifts

Birthday gifts

Vacations / travel

Tax payments

Major auto maintenance (like spending $800 for new tires)

Minor auto maintenance (like oil changes)

Car insurance

Vehicle registration

Property taxes and insurance (if not already covered in your escrow)

Annual vet check-ups / registration (if you have pets)

Donations

Even though most of them happen only once or twice throughout the year, when combined, they could add up to thousands of unplanned dollars. This is why annual budget works better. With an annual budget, you successfully account for each and every one of these miscellaneous but straining expenses.

With a monthly budget, it’s almost impossible to properly capture these periodic expenses. Unless you’re incredibly, super disciplined by setting aside a few hundred dollars per month (which most of us aren’t), then it’s not going to happen.

Missed Income

Expenses aren’t the only thing that might get missed with a monthly budget.

If you budget your money on an annual basis, you may also find a pleasant surprise: 2 extra paychecks!

Yes, for most people who get paid every two weeks, they can plan to receive 26 paychecks per year. But with a monthly budget, we falsely assume that we will only ever receive 2 paychecks per month, or 24 per year. In reality, that means we’re not accounting for 2 whole paychecks!

Anyone enjoy a nice Federal Income Tax refund? What about profit sharing or an annual bonus from your job?

Again, with an annual budget, you can capture all of it. This additional income will boost your overall cash flow, leaving you with more capital to work with. That gets you closer and closer to your goals!

Spotting Negative Trends Early On

One of my favorite benefits of budgeting annually is the fact that I can spot negative trends early on.

By having all my income and expenses laid out over a 12 month period, I can see exactly how much money will be in my bank account at the end of every month.

In a few months will my checking account get close to zero or in the red?

Good catch! Months before the damage is even done, I can make some adjustments to my spending that will put us back on the right track.

Building in Goals

The other thing I really like about annual budgeting over monthly budgeting is the fact that I can work in specific goals and see how they will influence our overall cash flow.

Remember those examples I gave earlier with the new car and 401(k) increase? Those were real goals (among many others) where I could add them to our annual budget and see how it affected the balance every month. By working with realistic estimates over the course of the whole year, I could see just how much we were able to afford.

Conclusions

If you budget your money, that’s great. But consider how an annual budgeting might be better than monthly budgeting over the long run. By getting the complete financial picture, you will properly plan for all your income and expenses … even those that happen only once throughout the year. But on top of that, you’ll also be able to better build in your goals, anticipate your cash flow, and set yourself up for financial success.

Readers – Which do you prefer between an annual budget vs monthly budget? What successes have you had, and what strategies do you use to make it work?

]]>http://www.mymoneydesign.com/personal-finance-2/savings-budgeting/annual-budget-vs-monthly-budget/feed/1http://www.mymoneydesign.com/personal-finance-2/savings-budgeting/annual-budget-vs-monthly-budget/What’s the Best Way to Retire Young? By Doing This One Important Thinghttp://feedproxy.google.com/~r/MyMoneyDesign/~3/Q1A3FArVYHI/
http://www.mymoneydesign.com/personal-finance-2/retirement/best-way-to-retire-young/#commentsSun, 31 Dec 2017 06:00:43 +0000http://www.mymoneydesign.com/?p=10297Have you ever wondered what sets you apart from people who retire young? All over the Internet, you can find incredible success stories of regular folks who were able to pull off the impossible. But what is their secret? How do you retire young in today’s world when so many of the odds seem stacked […]

]]>Have you ever wondered what sets you apart from people who retire young?

All over the Internet, you can find incredible success stories of regular folks who were able to pull off the impossible.

But what is their secret? How do you retire young in today’s world when so many of the odds seem stacked against you.

It’s one of my personal hobbies to read these stories and look through the details to see what makes them different. And you want to know what I’ve noticed?

It’s not that they won the lottery or received a huge inheritance.

It’s also not that they were necessarily big-time executives earning way more money than you and I.

No, the answer is actually much simpler than you might think. Most of the early retirement success stories I’ve read have one theme in common: They all involved extremely high savings rates.

It’s true. You can find this in nearly every case. But just exactly how high of a savings rate are we talking about? Let’s consult those who have actually retired young to find out.

How Much Do You Need to Save to Retire Young?

So what is the right proportion of your savings to stash away if you want to kiss the cubicle goodbye?

Probably one of the oldest cited blog posts come from Jacob at Early Retirement Extreme. In this article, he lays out a chart describing how many years each level of savings frees you:

If you save 5% if your income, you can take 1 year off every time you work 19 years.

…

If you save 50% of your income, you can take 1 year off every time you work 1 year.

…

If you save 90% of your income, you can take 9 years off every time you work 1 year.

Is this actually true? Check out these choice selections from some of the more popular early retirement blogs and see for yourself.

Mr Money Mustache calculates it would take 10.9 years to retire if you saved 64% of your income.

Mr and Mrs 1500 from the blog 1500 Days: “Right now, I think in our most efficient life, now that we’re not doing that, we save at least 75%. And our life isn’t compromised. We’re very happy. (From an interview on the Mad Fientist podcast).

Jeremy from the blog Go Curry Cracker: Our overall savings rate started relatively low (albeit high by average American standards), but as income rose and we learned how to be more efficient with our spending, our savings rate passed 70%.

Brandon from the Mad Fientist: My savings rate in 2014 averaged over 73% but I expect that number to be higher this year because my expenses have dropped dramatically.

Frugalwoods from their blog Frugalwoods: Mr. Frugalwoods and I finally did the arithmetic on our 2014 savings and expenditures (as I’m sure you’re all relieved to know). While in any given month of 2014 we vacillated between saving 65%-82%, our average savings rate for all of 2014 is 71.4%. Woot!

Noticing the same trend?

Why Does a High Savings Rate Help You Retire Young?

The math that connects early retirement and high savings rates is pretty interesting.

What most people don’t realize is that when you save more for retirement, you’re not just simply saving more money. You’re also training yourself to live on less income.

Take this simple example.

If you’re generally used to living on an after-tax income of $40,000, then you will need a nest egg of approximately $1,000,000 in order to retire (i.e. 25 times your expenses).

But if you can get your savings rate up, this means you automatically have less after-tax money to spend. Suppose your high savings rate left you with only $30,000. Now you only need $750,000 in order to retire.

Related posts:

]]>http://www.mymoneydesign.com/personal-finance-2/retirement/best-way-to-retire-young/feed/3http://www.mymoneydesign.com/personal-finance-2/retirement/best-way-to-retire-young/Financial Freedom Has Never Been About The Moneyhttp://feedproxy.google.com/~r/MyMoneyDesign/~3/MTXS342akSE/
http://www.mymoneydesign.com/lifestyle/philosophy-motivation/financial-freedom-has-never-been-about-the-money/#commentsSun, 24 Dec 2017 06:00:47 +0000http://www.mymoneydesign.com/?p=8904Christmas has always been a special time for me. As a small child, I would spend every night leading up to Christmas morning wondering what was going to be underneath the tree waiting for me. As a young parent, Christmas became a whole lot less about “what I wanted” and more about how much my […]

As a small child, I would spend every night leading up to Christmas morning wondering what was going to be underneath the tree waiting for me. As a young parent, Christmas became a whole lot less about “what I wanted” and more about how much my wife and I could surprise our kids.

When you’re in the hospital waiting to find out what’s going on exactly and how bad your situation really is, certain things tend to disappear from your mind entirely.

You don’t think about work. You don’t think about all the “things” you do and don’t have. You don’t even think about all the petty stuff that people did that annoy you …

Instead, you think about only one thing: You think about time. You think about whether or not you’ll be around to see your family, if they’ll be okay, and if you did everything you were meant to do with them …

There’s only one thing you want, and that’s for everything to go back the way it was before.

The Greatest Gift of All

When you receive chemotherapy and feel sick for days, the best possible gift you can get is when you start to feel like your old self again a few days later. It’s indescribable to be full of energy again. To have food taste good again. How great it is to simply breathe and not have any part of your body hurt.

When you start to get better, it feels great to be alive. And things look a lot differently than they did before. Your career doesn’t define you any more. Material processions don’t really make you feel anything. And some of the things other people get really passionate about or take so seriously seem down-right ridiculous.

People who are negative or miserable all the time make no sense to you. “Hey buddy, want to have REAL problems? Try discovering a giant tumor in your chest and then come talk to me about how inconvenienced you are”.

When you’ve been robbed of so much time, time has a completely different value than is used to. You finally understand that it is in fact “finite” – you will eventually run out of it. Time is a premium. You realize all you can do with time is make the best of it.

All you can do is give it your best shot while you’ve got the opportunity. Don’t waste your time pursuing the things that will ultimately leave you unfulfilled and unhappy. Give your love and attention to those who really need it the most. Make plans and goals to go enjoy the experiences you really want to get out of life.

Financial Freedom is Bigger Than Just Yourself

For years, financial freedom has been very important to me. And it still is. But now financial freedom represents so much more. It signifies not just the time to do as I please, but also the opportunity to make differences to those where I might have never otherwise been able to.

By turning our savings into a machine of labor-replacing income, I will ironically take money right out of my daily equation. Working won’t revolve around financial gain, because my savings will provide all that I could ever possibly need.

Instead, I will be able to focus on helping people and sharing my knowledge the way I want to. Not because it is tied to any sort of job or financial gain, but because I care. I can help other people to realize and achieve their own dreams and goals, and I will be able to do so without the artificial boundaries so many of us commit ourselves to.

And, depending on how our assets shift and grow, the sky could be the limit to what I am able to do with them. It could mean financial gain for future generations, or even funding other causes we believe in. I could create the gift that keeps on giving. This could be my legacy, and I’d have financial freedom to thank for it.

Financial freedom has never been about the money. Having “the most money” was never the end-goal. Money was just a tool. Money was just the coal that I shoveled into the hot furnace of a giant machine; a machine that I’m designing and perfecting little by little each day. A machine that will one day not just do great things for me and my family, but for others for years and years to come.

That’s the whole point. That’s what we’re saving for. Every dollar saved is creating something larger than life, larger than myself, and having a purpose that I can share with all of those who matter to me.

This Christmas, I’m thankful for getting the one thing I wanted more than anything this year: To be able to finish what I started!